Massachusetts estate tax hits the middle class

Massachusetts estate tax hits the middle class

Bill Harris on Massachusetts estate taxMassachusetts has an unexpected estate tax that’s catching lots of unsuspecting families. And you might be one of them.

The Massachusetts calculation to determine the tax is dramatically different than most states and the federal government’s method. Furthermore, it is out of date and arguably unfair. If you think the estate tax is only for the wealthy, think again.

The Massachusetts estate tax is regularly entrapping unsuspecting middle-class families. If you own a modest house in the greater Boston area and you’ve funded your IRA for an adequate retirement, your estate may get hit with the death tax. In estate planning circles, Massachusetts is the least desirable state in which to reside if you want to pass assets to your heirs.

Massachusetts implemented the current estate tax rules back in 2001. Unlike other states, it’s never been indexed for inflation. In the past three years, nine states have eliminated or lowered their estate taxes. Many more states are raising their lifetime exemptions (the amount that is excluded from estate tax calculation). New Jersey is scheduled to eliminate its estate tax altogether, joining about a half-dozen others that have ended their estate taxes over the past decade.

States are getting competitive for wealthy taxpayers. Since the federal estate-and-gift tax exemption became approximately $5 million in 2011 ($10 million for married couples), taxpayers have begun to pay attention to how their state implements the death tax. And, while most states have paid attention to this competitive threat, Massachusetts has decided to go in the opposite direction and scare taxpayers completely away.

Massachusetts and Oregon are tied for the worst place to die. These two states have estate-tax exemptions of $1 million and neither adjusts for inflation. Furthermore, Massachusetts is considering raising income taxes on millionaires. People are moving and will continue to move to other states because of this policy. Florida’s not only warm sunny, it’s tax policy is also welcoming.

As previously mentioned, the Commonwealth of Massachusetts has peculiar rules when it comes to the estate calculation.  The 2017 threshold for federal exemption was $5.49 million ($10.98 million for a couple) and it was just doubled under The Tax Cut and Jobs Act of 2017 which raised it to $11.2 million for an individual ($22.4 million for a couple), meaning if your estate tax is under that, you’ll avoid the estate tax. If your estate is over that, only the amount above the threshold is taxable. For example, John has a $12 million estate, only $800,000 will be subject to the estate tax.

The Massachusetts exemption threshold is only $1 million, much less than the current federal estate taxes. But unlike the federal estate tax, which only taxes the excess over the threshold. In Massachusetts the threshold is a trigger. The majority of estate becomes taxable (starting at $40,000). While the tax rate is less than federal, starting at 0.8 percent and capping off 16 percent, (the federal rate is 40 percent), it is snaring lots of taxpayers at death.

The tax on a $1 million estate is approximately $36,000, however the tax on an estate that is $999,999 is zero. If you are a Massachusetts resident and all of your assets combined are just a bit above $1 million, get below that threshold or change your residency before you die. Otherwise, death taxes will be due.

If you plan on gifting to get below the threshold, the Massachusetts gifting rules are also complicated. The federal system is set up to tax gifts above a certain amount. Massachusetts does not tax gifts at all. But Massachusetts will add back gifts to determine whether the decedent’s estate exceeds the $1 million threshold. Gifts are typically limited to $14,000 per recipient per year. This is often referred to as the annual exclusion. But if you give more than $14,000 in a year ($28,000 if you’re married) to one person, then you are supposed to file a gift tax return. For example, if you give someone $114,000, you must report a taxable gift of $100,000 (the $14,000 annual exclusion would not be reported). While you must report these amounts, you’ll only pay a tax if all of your taxable gifts combined exceed the federal estate tax threshold of $11.2 million ($22.4 million per couple). You can give that $11.2 million during your lifetime or upon your death and no federal taxes would be due.

While your gifts greater than the annual exclusion ($14,000) are typically irrelevant for federal tax purposes, they have an impact on the Massachusetts death tax calculation. Massachusetts adds back the gifts when determining whether your estate exceeds the $1 million threshold. For example, if someone with a $1.2 million estate gave each of his/her three children $100k each in addition to the annual exclusion ($300k total), the estate size would be lowered to $900,000. Upon death, that $300,000 must be added back to determine if the estate is taxable in Massachusetts. While the estate in this example is below the threshold, the gifts added back triggered the estate tax.

If you are at the threshold, estate taxes can be minimalized, but you need to plan. While the Massachusetts estate tax rate is significantly lower than the federal rate, it can often be reduced or avoided entirely through smart gifting strategies.

Estate planning mishaps are hitting the Massachusetts’ middle class all too often. Frankly, our legislative body needs to modernize our estate tax laws so that Massachusetts has a competitive system. Or we will continue to see our loved ones flee to more “warmer and friendlier” states.

A version of this article originally appeared in the Old Colony Memorial.

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